Friday, May 11, 2012

Investment Analysis: Selling and Administration Expenses

This is the last of the quality of earnings factors that I look at.  Just for complete disclosure, Lev & Thiagarajan have six others.  I'll do a brief post on those to explain them and why I choose not to use them at another time.

This signal is similar to the last one we looked at, "Gross Margin".  Many S&A costs are fixed in the short term and a disproportionate changes relative to sales are rich in information.  We look at the percentage changes and the formula is:

% change in sales - % change in S&A.

If the result is negative, it is a negative signal, if it is positive, it is a positive signal.

In Verdasis, we set up an analysis template that has four elements:
  • Total Revenue, Y
  • Total Revenue, Y-1
  • Selling/General/Admin Expenses, Y
  • Selling/General/Admin Expenses, Y-1
If you need more how-to, we have a video tutorial here.  The third one shows how to set up templates.

(I'll just also point out that once you've set up the templates, you can use them again and again on different portfolios.  We're also playing around with different ideas to make the investment analysis process faster with per-fabricated ratios - some users will set up their own propitiatory ones and others will be available for all users for a fee.) 

Once the information is exported to the spreadsheet, calculate the percentage changes and take the difference.  I am using a 5% band around zero to remove the small changes as I did in Gross Margin.  If there is missing data, for example one of the stocks is missing the S&A information and I got the "dividing by zero" warning, I manually enter a "zero" for the final rating.

You can see the spreadsheet here.

OK, exciting times!  All done the quality of earnings analysis and next post I'll bring it all together by summing the ratings.  Hopefully you are starting to get a sense of how bringing this financial statement data into context gives us true, meaningful insight into these companies.  This stuff is a lot deeper than most of the everyday common ratios that we can easily find on financial web-sites and in the press.

But the proof will be in the pudding - once we're done (all done, there is still some more analysis we have to do, this is just the start) I'm going to take a position and we'll see how the pick performs vis a vis the rest of the group and the market.

Thank you for reading, have a great weekend!

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